Annuities: A Primer

Annuities: A Primer (Updated 12/20/07)
There are two broad categories of annuities: deferred annuities and immediate (or income) annuities. Within those categories are two sub-categories: fixed and variable annuities. Thus, there are four basic types of annuities. This primer will attempt to describe each of them.
Deferred Annuities are used to accumulate assets. Funds will grow at a rate that can be either fixed or variable.
Fixed Annuity
The money you put in a deferred fixed annuity earns interest at a rate that is guaranteed for a specific period of time—ranging from one to five years or more, depending on the terms of the contract. When that period ends, a new rate may take effect—or the old rate may be offered again. In no case will the new interest rate be less than the guaranteed minimum rate defined in the contract.
Variable Annuity
With a deferred variable annuity, your money is put in subaccounts that are invested in stock and bond funds. You can move your money from one subaccount to another without incurring taxes. The return on your investments is subject to the risk of market fluctuation. Your total account value depends on the asset mix (how much in stocks and how much in bonds), the performance of the subaccounts and what charges and fees are deducted. These factors are explained in the annuity’s prospectus, which outlines the objectives and level of risk for each subaccount, operating expenses and financial statements.
Over the long term, variable annuities reflect growth in the economy and may serve as an effective hedge against inflation. However, it is possible to lose money in a variable annuity. Some variable annuities allow you to place some of your money in a fixed account with a guaranteed rate of return. Such diversification helps spread your risk. There are also optional guarantees that can be purchased to provide additional protection against downturns in the market.
Immediate (Income) Annuities are used to convert a lump sum into an income stream (regular payments). If the income stream is fixed, it is considered a fixed immediate annuity. Some fixed immediate annuities are offered with inflation-adjusted payments or graded payments that rise at a fixed rate, of for example, 3% annually. However, these options reduce the initial payment received but with the anticipation that payments will grow steadily over time.
If the income stream is variable, it is considered a variable immediate annuity. Like deferred variable annuities, your money is put into subaccounts. These subaccounts can be invested in stock or bond funds. Payments will fluctuate based on the performance of the underlying subaccounts. With funds invested in stocks, it is possible that payments could grow at a rate higher than can be achieved by fixed immediate annuities.
Income Options from Immediate Annuities
Life income
You receive income as long as you live, even if payments exceed the amount of money you put into the annuity. When you die, no further payments are made to anyone. This income option, also referred to as a straight life option, usually provides the highest income payment.
Joint and survivor life income
This option provides income for as long as you or the joint annuitant live. Because the survivor feature is an added benefit, the income payment is less than in a straight life option.
Life income with refund
You receive income for life and, if you die before receiving the amount of money you contributed, your beneficiary collects the portion you had not yet received. Some policies pay the beneficiary a lump sum, and others may require benefits to be received in installments.
Life income with period certain
Payments are made to you for as long as you live with the guarantee that, if you die within a certain period after you start receiving income (usually 10 or 20 years), your beneficiary will receive regular payments for the rest of that period.

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Reference: The Individual Annuity: A Resource in Your Retirement (pdf)